Stranded Costs Revisited

cost calculation should be made on a portfolio basis, with earnings in excess of sunk commitments

for some

units being used to offset (at least partially) unrecovered sunk commitments from others. Second, Joskow is correct to note that a utility should only compete tor sales when its avoidable costs are below market prices. What is not clear is whether his proposed mechanism accounts for all the factors that will afthe recovery process) are consistent with my own.’ Joskow’s discussion of developing to

an ongoing stranded cost mechanism,

the

however, raises at least three issues.

Editor

First, Joskow is not explicit about whether his mechanism should be applied only to individual assets and liabilities whose operating earnings fail to exceed their sunk cost commitments. This is an important issue. If stranded cost recovery estimates include only these plants, then the stranded cost charge for electricity users will certainly be greater than if all the utility’s assets and liabilities are assessed as a portfolio. When the util-

Stmnded Costs Revisited

ity’s assets and liabilities are viewed as a portfolio, a generation unit’s eam-

T

ings in excess of its sunk cost commit-

here is much to recommend in

ments can be used as a credit against

Paul Joskow’s examination of

another unit’s sunk cost recovery defi-

stranded cost recovery and efficient

cit. Regardless of whether analysts

competition (“Does Stranded Cost Recovery Distort Competition?”

use asset-by-asset approaches or

April

more aggregate methods to estimate

1996). Indeed, his primary views (i.e.,

stranded costs, there is widespread

stranded cost recovery need not con-

agreement that a utility’s stranded

flict with efficient competition if the recovery charge and marginal genera-

Address correspondence to:

ately from total electricity costs;

Letters to the Editor The Electricity Journal 1501 Western Avenue, Suite 100 Seattle, Washington 98101

and re-

covery should be addressed when restructuring frameworks are implemented; and developing stranded cost measurement mechanisms will

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be an important technical hurdle for

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compete. An ORNL report noted that a utility has two choices when competing for retail sales: it can lose sales and attempt to resell some or all the lost sales on the wholesale market, or ’ it can lower its price to the market price and thereby keep the sale.” The report finds that estimates of stranded costs often differ considerably depending on whether the utility loses or keeps retail sales. The key factors affecting this difference include market prices (and any difference the utility sees between its purchase and sale prices), utility marginal production costs, the percentage of retail load at risk, and available transmission capacity. A utility may incur marginal generation costs in excess of market prices when it does not have sufficient transmission capacity to import the marketpriced power necessary to satisfy demand. If a utility had infinite transmission capacity, then this would not constrain the utility, or its distribution customers, from interacting with the larger market, and the

tion costs are unbundled appropristranded cost measurement

fect a utility’s decision, or ability, to

Please include a daytime phone number. Submissions may be edited for length.

keep-sale and lose-sale distinctions would be unimportant for Joskow’s mechanism. Third, while I agree completely with Joskow’s recommendation

for

establishing appropriate incentives to ensure efficient cost recovery, adopting performance benchmarks for indi-

Tlze Ekcfricify

]mrna/

vidual generating units or a utility’s

ing for the latter two components is

competitive price position of natural

entire system will not be easy. Even

not meaningful. When retail custom-

gas. While generally an accurate rep-

in states with sufficient numbers of

ers gain direct access to the wholesale

resentation of our study, the article

well-trained public utility commis-

market they should be able to obtain

misinterpreted one of our conclusions

sion staff, utilities know the econom-

prices that are equivalent to whole-

by stating that gas cooling “is not

ics and performance of their systems

sale prices. To the extent that there

promising“ in the Mid-Atlantic Area

better than regulators. A utility capa-

are frictions associated with retail cus-

Council (MAAC), the Northeast

ble of generating electricity at costs

tomers taking advantage of direct ac-

Power Coordinating Council (NPCC)

below the market will have an incen-

cess opportunities, it is technically

and the Western Systems Coordinat-

tive to set the performance bench-

true that the stranded cost computa-

ing Council (WSCC) regions.

mark as close as possible to the mar-

tion might be smaller, but this would

ket price in order to capture the

merely reflect the fact that some cus-

competitive market gas likely will ex-

margin between the market and its ac-

tomers are effectively paying for the

perience a reduction in its present

Our study found that in an openly

tual production costs. Regulators will

rest of the stranded costs by not tak-

summertime price advantage in cer-

need to establish these benchmarks,

ing advantage of lower prices avail-

tain markets within these three re-

or other efficiency incentives, with

able in the wholesale market.

gions. From this, it can be appropri-

some care. -Lester W. Baxter, Oak Ridge National Laboratory

3. Finally, I certainly agree that

ately inferred that in such market

regulators will have to establish the

segments open access may make it

relevant generation performance

more difficult for gas cooling to com-

benchmarks with some care. I hope

pete against electric cooling. How-

Endnotes:

with at least as much care as they

ever, one cannot conclude that gas

1. L. Baxter, Dt@rent Approaches to Estimating Transition Costs for the Electric-Utility

take in fulfilling their other responsi-

cooling “is not promising” in these re-

bilities. A yardstick regulation ap-

gions in an absolute sense.

Industry, ORNL/CON-423, Oak Ridge Nat’1Lab., Oak Ridge, Term. (1’9%).

proach may be the best type of regulatory mechanism to consider since

gas technology will be cost-effective

2. E. Hint, S. Hadley, and L. Baxter, Meth-

there are so many generating units

relative to electricity on a total life cy-

ods to Estimate Stranded Commitments for a Restructured U.S. Electric Industry, ORNL/CON424, Oak Ridge Nat’1 Lab.,

against which performance can be

cle basis requires analysis of numerous

benchmarked.

factors, including, but by no means

-Paul L. Joskow, Mitsui Professor of Economics and Management, Head, Department of Economics, MIT

Oak Ridge, Term. (1996).

Paul Joskow Responds:

L

et me respond briefly to the three points raised by Mr. Baxter.

performed on a de facto “portfolio” basis. Assets or contracts that have values that are “above market” must be netted out against those that are “below market.”

clude a generation cost component, a distribution and retail service cost component, and a transmission cost component. Comparing retail rates with wholesale rates without adjust-

July 1996

tions of competing fuels. The RJRA analysis referred to in your article pact of electric restructuring on the

Gas

Cooling Is Cost-Efictive

competitive price position of natural gas relative to electricity and did not

he News in Focus“ section of

/I T

the April 1996 issue of The

Electricity Journal referenced a study performed by R.J. Rudden Associates, Inc. (RJRA) on the potential effects of electric restructuring on the

2. I do not think that Baxter’s second point is correct. Retail rates in-

limited to, the competitive price posi-

purposely concentrated on the im-

1. Yes, certainly I expect any reason-

able stranded cost computation to be

To determine whether a particular

draw any conclusions as to the cost effectiveness of any gas technology on a total life cycle basis. Other analyses performed by our firm, however, have compared gas cooling to electric cooling on a total life cycle basis in various regions of the U.S. Indeed, in some specific cases that we have stud-

Erratum The Letter to the Editor in the June 1996 issue of the Electricity Journal in response to an article by Paul Joskow was wriien by Steven A. Mitnick, a director of Hagler Bailly, Inc.

ies we have found that the life cycle costs of gas cooling continue to be favorable even after accounting for the effects of electric restructuring. -Rehan

Gilani, Senior Consultant, X.1. Rudden Associates, Inc.

3